The Long and Short
Higher yields for reduced liquidity in life insurance P-CAPs
Dan Bruzzo, CFA | December 2, 2022
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
There is a unique trust structure utilized primarily by insurance companies that allows a company to issue debt, but keep leverage off the balance sheet until, or if, the funds are eventually needed. Such bonds are called pre-capitalized securities (P-CAPs), and they trade in the secondary market at a sizable discount to comparable senior unsecured debt from the same issuer. Investors are extremely well compensated for the perceived give-up in liquidity to move into these structures, which offer comparable capital structure positioning to standard unsecured life insurance debt. The LIFEVT ‘51s, issued by National Life Group out of the Maple Grove Funding Trust, are P-CAPs that offer significant value relative to higher-rated life insurance peers.
Exhibit 1. LIFEVT ‘51s vs Life Insurance comps (BBB+ or higher ratings)
LIFEVT 4.161% 08/15/51 @ +270/OLB; G+270; 6.38%; $70.94
Issuer: Maple Grove Funding Trust I
Amount Outstanding: $750 million (Index-eligible)
Senior Debt Rating: Baa1/BBB+
Insurance Financial Strength Ratings: A1/A+
Precapitalized Securities (P-CAPs)
144a Private Placement
LIFEVT is a privately held operator in the life insurance and retirement savings space. The company’s core products are fixed indexed annuities and indexed universal life, with a strong presence offering retirement solutions in the education space, also known as the K-12 segment. Group statutory life assets are $35.8 billion with total cash and investments of $33.7 billion, and total policy reserves of $24.5 billion.
LIFEVT is very well capitalized with AAA capital redundancy rated by S&P. Total capital and surplus as of 2Q22 was $2.6 billion, or about 7.8% of total assets. The statutory life risk-based capital ratio (TAC/ACL RBC%) was 962% as of year-end 2021.
The company has a very solid liquidity profile, with no public debt maturities until 2033 and the bulk of debt outstanding in the long-end of the curve.
S&P estimates financial leverage to be about 18% as of year-end 2021 and expects it to remain below 25% for the intermediate term.
Primer – Precapitalized securities (P-CAPs) offer attractive spreads over comparable senior notes
Precapitalized Securities or P-CAPs are a unique trust structure utilized by insurance companies seeking to issue debt, but also wanting to keep leverage off the balance sheet until or if the funds are eventually needed. The bonds trade in the secondary market at a sizable discount to comparable senior unsecured debt issued by the same insurance companies. We believe investors are well compensated for the moderate give-up in liquidity and structural implications associated with these securities. Some other examples of P-CAPs in the insurance industry include: Prudential Financial’s (PRU: A3/A/A-) Five Corners Funding Trust, Equitable Holdings’ (EQH: Baa2/BBB+) Pine Street Trust, Voya Financial’s (VOYA: Baa2/BBB+) Peachtree Funding Trust, the Belrose Funding Trust issued by Lincoln National (LNC: Baa1/A-/A-) and High Street Funding Trust issued by Principal Financial Group (PFG: Baa1/A-/A-).
The motivational concept behind a P-CAP is fairly simple. The issuer creates a trust that accesses the public debt market, but that debt is held off balance sheet of the insurance company and does not contribute to financial leverage. The proceeds of the securities issued by the trust are used to purchase Treasuries (principal or interest strips), from which the trust will pay a coupon plus a locked in spread rate that is paid/provided by the underlying insurance company. In effect, it is a means for an insurance issuer to essentially lock in or create an option on interest rates at a time when they view rates as attractive but might not necessarily need to issue debt. The company has a put option to issue senior unsecured debt into the trust at any time and take ownership of the treasury securities that are held (typically at increments of $50 or $100 million depending on the terms of the deal). Only at that point does the debt count toward financial leverage and the issuer have access to the funds.
All outstanding P-CAPs are rated in-line with the senior unsecured debt of the issuer, as the rating agencies view the credit quality as being closely linked to that of underlying insurance company. The notes issued into the trust upon exercise would be pari passu with all senior unsecured debt obligations of the underlying insurance company. An issuer would choose to execute voluntarily in the event that it could no longer access the public debt markets or simply views current rates as unattractive to issue new debt. Debt issuance to the trust can also occur as a result of a mandatory exercise event, which we describe below. So far, no insurance company that has issued P-CAPs has ever exercised either voluntarily or through automatic/mandatory action.
An automatic exercise event occurs if either a bankruptcy event occurs at the underlying insurance company, or if the company fails to make scheduled payments to the trust. A mandatory exercise event would occur if consolidated net worth of the company falls below a certain threshold, or if the company defaults on other payments or violates debt covenants. In either case, the senior debt then issued to the trust puts holders of the P-CAPs in a pari passu position with other senior debtholders of the insurance company.